Report No. 1586b-ZA

Zambia-A Basic Economic Report FILE COPYAnnex 1: Mining Sector ReviewOctober 14, 1977

Country Programs DepartmentEastern Africa Regional Office

FOR OFFICIAL USE ONLY

Document of the World Bank

This document has a-restricted distribution and may be used by recipientsonly in the performance of their official dcties. Its contents may nototherwise be disclosed without-World Bank authorization.

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CURRENCY EQUIVALENTS

Prior to February 1973 February 1973 to July 1976

US$1 = K 0.7143 US$1 = K 0.643K I = US$1.40 K I = US$1.554

Since July 1976

SDR I = K 0.9218K I = SDR1.0848

US$1 = K 0.8000 (July-December 1976 average)K I = US$1.2499 (July-December 1976 average)

US$1 = K 0.7952 (Jan.-June 1977 average)K I = US$1.2576 (Janw-June 1977 average)

ABBREVIATIONS

CIPEC - Intergovernmental Council of Cooper Exporting CountriesCSO - Central Statistics OfficeLME - London Metal ExchangeMINDECO - Mining Development CorporationNCCM4 - Nchanga Consolidated Copper Mines LimitedRCM - Roan Consolidated Mines LimitedSNDP - Second National Development Plan (1972-76)TAZARA - Tanzania-Zambia RailwayTL III - Tailings Leach Plant Stage III Project (at NCCM's

Chingola Division)TNDP - Third National Development Plan (1978-82)ZIMCO - Zambia Industrial and Mining Corporation

WEIGHTS AND MEASURES

tons = metric tonsI metric ton 1,000 kilogramsI metric toa = 0.984 long ton1 metric ton 1.102 short ton

FISCAL YEAR

Government - January 1 to December 31Mining Companies - April 1 to March 31

FOR OFFICIAL USE ONLY

ZAM!BIA BASIC ECONOMIC REPORT

Annex 1: Mining Sector Review

Table of Contents

Page No.

List of Figures and Tables ...... ...................... i

Glossary of Terms ... .................................. ii

1. Summr and Conclusions .. ................... I

II. Orzanization of the Mining Industry. 6

A. Major Operating Entities. 6B. The Role of Government in Mining

Operations ........... ... 7

III. Sectoral Policies and Recent Performance 8

A. The Second National Development Plan( ',N1P ..... . . .. .. .. . . .. . . .

B. Sect:oral.Performance in the SNDP Period . 9

:V. Current Operating Conditions ........ * ...... 13

A. Reserves ................... *...........* 14B. Production Capacities ..... .............. 16C. Production costs ..... ................... 19

V. Determinants of Future Production .. 28

A. Reserves .............. ...... a...29B. Production Capacities .31C. Ptogduct±on Costs ... . ... . .. . . ........ 34D. GovaLrrment Policies and Actions 37

Vl. Future Course of Production . .42

This document has a restricted distribution and may be used by recipients only in the performanceof their olficial duties. Its contents may not otherwise be disclosed without World Bank authonzation.

List of Figures and Tables

Page No.

Figure 4.1: Principa!l Material Flow Alternatives inZambian Copper Production ..... ................ 17

Table 3.1: Zambian Production and Exports of Copper,1970-1976 ............. ........................ 9

Table 3.2: Capital Expenditure by Zambian MiningEompani9 s. 1972-1976 .12

Table 4.1: Development in Copperbelt Mines, 1970-75 15

Table 4.2: Ore Reserves at Co2perbelt Operations, 1969-75 . 16

Table 4.3: Average Production Costs Per Ton of FinishedCopper Ln Copperbelt, 1970-1/1975-6 .... ........ 20

Table 4.4: Ore Produced Per Ton Finished Copper Production,1969-75 . ... 22

Table 4.5: Copperbelt Labor Productivity, 1969-75 .24

Table 4.6: Copperbelt Labor Force. Turnover and AverageLength of Service. 1969-75 .26

Table 4.7: Value of Mining Companies' Stores, 1970-75 28

Table 5.1: Some Currently Known Deposits of Copper OreOutside Current Mining Complexes .30

Table 5.2: Estimated Capital Expenditures, 1977-81 .33

Table 5.3: Forecasted Number of Graduates in Mining andRelated Fields from University of Zambia,1977-78 .......................... o................... 36

Table 5.4: Government Revenues and Retentions from MiningCompany Earnings. 1970-75 ...................... 38

Table 6.1: Proiections of Finished Copper Output fromCopperbelt, 1977-85 ....... . . .... .... 44

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Glossarv of Technical Terms

(Note: A schematic diagram of principal material flows in Zambian copperproduction appears following paragraph 4.05 in the text, which illustratesthe relationship between the various stages of copper processing explainedin this glossary.)

CONCENTRATOR: A plant which separates ore into economicallyvaluable products (coucentrates) and rejects(tailings).

CONTAINED The amount or percentage of copper metal containedCOPPER (Cu): in ore reserves in situ or in the products of sub-

sequent processing of the ore. (A small portionmay be lost in processing.)

DILUTION: The mixing of waste rock with ore.

ELECTRO-WINNLNG: Recovery of a metal by means of electrochemicalprocesses. The product, CATHODE COPPER, requiresmelting in a furnace to be marketable as electro-lytic copper.

FINISMfl COPPER: The marketable (99+ percent pure) metal which isthe product of the various processing stages.

FLOTATION: A method of separation in which a froth created inwater is used, with a variety of reagents, to floatfinely ground metal minerals whereas other mineralssink.

LEACHING: The extractiou of a soluble metallic compound froman ore or concentrate by selectively dissolving in asuitable solvent, such as sulphuric acid. The solventis usually recovered by precipitation of the metal ormetals.

ORE: A naturally occurring mineral containing metals whichcan be mined at identified places at economic benefit.

RECOVERY RAZE: The ratio of copper metal contained in the product ofone metallurgical process to the metal contained inthe material fed in.

REFINING: The purification of crude metallic products. Incopper, represents the final stage in the processingto relatively pure metal. Usually accomDlished byelectro or fire methods. Product is usuallv calledELECTROLYTIC COPPER.

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RESERVES (IN SITU): Natural concentrations of ore in the ground(see paragraphs 4.02-4.04 for explanation ofdifferent categories of reserves). The GRADEof reserves refers to the percentage of containedcopper in the ore.

ROASTING: Reseting an ore or concentrate to effect some chemicalchange that will facilitate smelting. For sulphideores, the roasting converts the sulphides to oxides.

SMELTING: A metallurgical operation in which metal is separatedby fusion from those impurities with which it may bechemically combined or physically mixed. In copper,the metal is usually obtained as a molten matte. Theproduct contains usually 70% copper.

TAILINGS: The rejected product of concentrating, which in somecases (depending on metal content) is leached torecover additional metal.

CHAP'IER 1. SUK2ARY AND CONCLUSIONS

1.01 From independence until 1975, the mining sector, and especiallycopper, 1/ accounted for an average 35% of Zambia's GDP, 45% of governmentrevenue and 95% of export earnings. After the dramatic 40% fall of worldcopper prices between 1974 and 1975, the current price share of mining pro-duct in GDP dropped to 10.0% in 1975 and 11.4% in 1976. The sector's contri-bution to government revenues declined even more steeply, to 13.3% in 1975 and2.6% in 1976. Because Zambia's total export revenue varies closely with itsearnings from metal exports, the share of such declining revenue accounted forby mining exports has remained relatively constant. These recent events havecaused Government to strengthen its efforts to diversify the Zambian economy,but the mining sector retains its dominant place in the economy and is stillthe principal source from which the country can hope to extract the savingsand foreign exchange needed to fuel large-scale development in other sectors.If the expected recovery in world copper prices takes place, and if appropriateactions are taken to provide the necessary financial and manpower resources toallow for effective expansion of productive capacity and to maintain a competi-tive cost structure, Zambia could expect once again to reap from the miningsector significant returns essential to its overall development efforts. Suchprogress in mining is also contingent on continued reliable access fromlandlocked Zambia to its overseas customers and suppliers, a factor over whichGovernment does not, of course, exercise control.

1.02 The Zambian Government, through its parastatal holding company(ZIMCO), has since 1970 held a 51% share in the two mining companies currentlyproducing copper in the Zambian Copperbelt, and a majority or full share incompanies prospecting or developing reserves in other areas of the country.Government has, therefore, direct influence on the operating and investmentdecisions of the companies. The exercise of this proprietary influence andGovernment's normal regulatory authority may at times lead to higher unitproduction costs (e.g., by encouraging maintenance of production at certainhigher-cost mines), but this been compensated for by the companies' developmentof new and lower-cost operations such as leaching plants. Sectoral capitalrequirements are high, however, and due to low profits or losses in recentyears, the need for foreign borrowing has risen considerably. Low worldmarket prices for copper and foreign banks' general reluctance to expand theirlending to Zambia have made it increasingly more difficult to obtain suchfinancing.

1/ This annex is concerned specifically with the production and export ofcopper. Zambia also produces significant quantities of cobalt (1975production: 3,000 metric tons), lead (18,800 tons) and zinc (26,200tons) for export, and coal (898,000 tons) for local consumption.Copper is by far the most important product of the mining sector,however, accounting for over 95% of the (real) export value of thesector as a whole. Production of non-copper metals has been rela-tively constant over the years and is expected to follow a similarcourse in the future; attention is therefore focused on copper pro-spects alone.

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1.03 The Second National Development Plan (SNDP, 1972-1976) clearlyestablished an optimistic goal of 900,000 tons of copper production in 1976,which was not (nor will it probably ever) be reached. Production of coppertotalled only 712,900 tons in 1976, just 2.1% higher than the amount produced,in 1972 (698,000), and about equal to Zambia's highest recorded production (in1969). 1/ Not only was the target an unrealistic one, but several otherfactors prevented the programmed expansion in output from occurring. Chiefamong these were major technical setbacks such as the longer than expectedrecovery period at Mufulira mine (after a disastrous cave-in in 1970).Moreover, capital expenditure was about K 320 million (in 1969 prices) overthe SNDP period, or 20% less than the planned amount, and large portions ofthis capital went to finance replacement expenditures. 2/ Capital investmentwas especially low in the closing years of the SNDP period when cash flowswere tight and price prospects gloomy. Finally, production and exports werereduced due to the falling productivity of labor, attributable largely totechnological and geological reasons, t6 the increasing turnover and de-creasing experience of expatriate staff, and to delays in shipping orshortages of vital inputs resulting from the interruptions of transportroutes (including the loss of rail access to the port of Beira in Mozambiquewhen the Rhodesian border was closed (1973) and the subsequent closing of theBenguela Railroad through Angola (1975)).

1.04 Geological, technological and economic factors affecting the levelof copper supply in recent years are reviewed in detail in Chapter IV. Theyinclude ore reserves, the production capacities of mines and processingfacilities, and current operating costs. Total reserves of contained copperwere 26.3 million metric tons at the end of 1975, a figure which has remainedrelatively constant over the years as exploration and development of newreserves have compensated for those being mined. Enough of these reserves arenow customarily developed to permit production schedules to be sustained for 9months ahead, which for practical operational purposes is an adequate level.However, the reduction in development in 1975 and 1976 could cause futureproduction problems.

1.05 While reserves of contained copper have remained relatively constant,the grade of ore reserves has been steadily diminishing (due largely to the

1/ To give an indication of Zambia's standing among world copper producers,copper production in Zambia accounted for about 9.2% of world productionand about 14.9% of world exports in 1975.

2/ Discussion in this annex of capital expenditures, as well as operatingcosts, is based largely on company accounts. The mission has interpretedthese accounts (as specificallv defined in detail in the text) in orderto provide estimates of capital requirements and costs for purposes ofprojecting future copper production and sectoral value-added in thisannex and in the main revort. The failure of the mining companies tofollow international princioles of accounting and the lack of consis-tency over time in the accounting principles applied make these estimatesvery approximate, however.

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selective mining of higher than average grades of ore). This has meantthat greater quantities of ore have had to be mined for similar levels offinished copper production. M4ining, which accounts for about one-half theunit production costs of finished copper, is done both underground and withopen-pit methods in Zambia. The relative shares produced by each of thesemethods has been relatively constant in recent years, but the generally moreexpensive underground mining (currently accounting for 70% of ore produced)is expected to account for a slowly rising proportion as Copperbelt reservesmineable by open-pit methods are depleted. One development which has helpedslow this upward cost trend is the increasing capacity (at Chingola) toextract (by "leaching") substantial amounts of finished copper from oldtailings, or stockpiled residues from past processing of ores, at a productioncost of up to 50% less than for conventionally mined and processed ores.

1.06 Production costs per ton of finished copper have risen at an averageannual rate of 12.7% over the 1972-76 period, from K 518 to K 943 per ton(in current prices). Direct production costs (mining and processing operations,through the refining stage, and mine administrative costs) in 1975-76 averagedK 700 per ton, or 75% of the total, with indirect expenses (company administra-tion, marketing costs and interest charges) at about K 243 per ton. Indirectexpenses (especially finance charges, following on recent heavy borrowing bythe mining companies) have been rising as a percentage of total costs.

1.07 The mission estimates that real unit production costs have beenrising at an average annual rate of approximately 2.7% since 1970. The largestportion of this real unit production cost increase is the need to produceadditional tons of ore per ton of finished copper. In addition, the cost ofproducing each ton of ore is also rising, due in part to the fact that mininghas had to be done deeper (involving increasing ventilation, materials handling,air conditioning and pumping costs). Further real unit production costincreases are related to the necessity of treating (concentrating) the addi-tional ore produced. An especially significant factor in rising costs is thedecline in labor productivity. This decline is due in part to the decreasingquality or availability of capital equipment resulting from the shortage ofimported spare parts and of maintenance personnel. It is also due to thegrowing turnover, lesser experience and often persistent vacancies on miningcompany staff of skilled (largely expatriate) personnel, whom Zambia has notbeen able to attract because of the southern African political situation,rapidly declining living standards, and increasingly uncompetitive Zambiansalaries. 1/ A final cost element which rose dramatically in recent years butis now leveling off is that of expensive and very large input inventoryrequirements, now of lesser concern as the means of obtaining and transportingintermediate and capital goods become more dependable.

1/ The declining competitiveness of salaries offered in Zambia is due notonly to the faster rising level of remuneration offered by othercountries but also to the uncertainty among Zambia company employeesabout their ability to convert their Kwacha earnings to foreignexchange.

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1.08 Future production levels, on the basis of which levels of companyearnings and government revenues are subsequently forecast, will depend onthe future course of the production variables mentioned above, world marketprices and on certain government policies and actions, all of which are con-sidered in Chapter V. Current reserves are sufficient to allow 20 yearsof production at expected extraction and recovery rates, although the costs ofextracting ore from aging mines at declining grades may become so high thatnew deposits would have to be developed in order to maintain projected levelsof finished copper production. More than six million additional tons ofcontained-copper have been identified in deposits outside current miningoperations, but their development (especially those located outside theCopperbelt), while perhaps helping to keep down operating costs, would requiresubstantial amounts of capital expenditure. It is also expected that invest-ment will soon be undertaken to develop facilities for producing up to 40,000additional tons of copper annually (by 1981) chrough the relatively lessexpensive process of "leaching" old tailings.

1.09 Although Zambia is one of the world's two biggest exporters of cop-per (behind Chile), it alone cannot manipulate the world copper price, norhave its attempts with CIPEC partners had success in stabilizing prices ata relatively high plateau. Price prospects are nonetheless quite hopeful,with IBRD projections of a doubling of (current) copper prices from 63 d/poundin 1976 to $1.20/pound in 1980, and it is up to Zambia to produce what it canto take advantage of such favorable conditions. Effective smelter capacitymay have to be increased, but otherwise sufficient processing facilities exist(if properly maintained and staffed) to treat expected ore production in therange of 700,000-750,000 tons of contained copper per year, using a number ofalternative processing methods.

1.10 Substantial capital investment will be necessary to maintain orslightly expand mining capacity (including replacement of some productionwhich will inevitably decline at older operations). The mining companiesprojected capital expenditures of K 637 million for the TNDP period are,in real terms, aearly 20% less than was spent in the previous plan period.They should be sufficient, however, to cover necessary general maintenancework and to develop fully two major new projects, at 3aluba mine (to offsetexpected falls in production at the neighboring Luanshya mine) and at theChingola Tailings Leach Plant Stage III (see paras 1.05, 1.08). Lf copperprices develop favorably, capital for these investments could be available toa large extent from company profits. The extent to which this occurs willalso determine the companies' ability to obtain the substantial loan capitalnecessary, at least in the near term when expected profits must also be usedto service recently incurred sizable foreign debts. Major development proj-ects largely prepared but not yet firmly in capital investment plans (suchas Kansanshi and Kalulushi East), which could be justified if prices risesufficiently, would recuire substantial addicions to capital expenditureplans.

1.11 One major decerminant of the mining comnanies' ability to raiseaeeded capital (both internally and as a means of actracting outside invest-ment) is the level of their operating costs. Ihe mission concludes that the

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annual rate of (real) cost increase, which has been around 2.7% since 1970,should continue into the foreseeable future or decrease slightly. Providingthat copper prices develop along the lines currently projected by the IBRD,this conclusion presents little cause to fear that mining in Zambia, whilerelatively high-cost, will become either uncompetitive or unprofitable.(This assumes, as the Bank projections do, that the real price of copperwill continue to rise, and that trend inflation rates of both costs andprices will not be out of alignment.) Efforts will have to be made to keepindirect operating expenses (finance charges, marketing costs, etc.) in lineas well.

1.12 The course of government policies and actions will also help deter-mine future production levels, largely through their impact on capital expen-ditures and operational costs. With regard to capital investments, Governmenthas a voice as majority shareholder in selecting new development projects tobe undertaken, and can also influence these choices by several of its mining(licensing, extraction, etc.) policies. Government also affects the cost andavailability of finance. It effectively precludes the raising of equitycapital (by neither rai.sing its own equity participation nor allowing othersto do so, in order to maintain its 51% share). Government's adverse impacton other sources of finance follows from taxation and dividend policies (whichhave restricted retention of earnings to as low as 16% of profits beforedepreciation in 1973), and from exchange policies effectively linking thecreditworthiness of' the mining companies to that of the country (by requiringthat all foreign exchange earnings be converted to Kwacha). The availabilityand terms of finance are thus affected particularly because of the currentlyweak international credit standing of Zambia.

1.13 Government policies and actions will have a direct bearing on thecompanies' production costs, which likewise influence levels of output. Thequestion of greatest present concern is that of labor productivity and avail-ability, which the min:Lng companies believe can only be remedied by Govern-ment's approval of improved expatriate compensation. This problem is notonly one of rising cost:s due to declining labor productivity, but also oneof decreasing effective capacity of operations because of a shortage ofskilled labor (this is especially important at smelters). Also of concernto the companies is their apparent inability to obtain adequate and timelyallocations of foreign exchange with which to provide necessary importedequipment (despite government efforts to improve the situation), which hasalso contributed to the need for maintaining larger inventories of spareparts. Government may also affect production levels through its extractionand reserves policies, which have a direct bearing on the grade of ore pro-duced and thus on mining requirements and costs. Finally, should CIPECagreements to restrict production for export be more faithfully carriedout by Zambia and other members, output levels could shift accordingly atGovernment decree, but this is considered highly unlikely in light of recentexperience.

1.14 While it is difficult to predict accurately the future movementof the wide range of interconnected variables which determine actual output,both the relative stability of performance by Zambia's mining sector in the

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face of recent adversities, and the fact that the large size of its opera-tions makes rapid changes in production unlikely, help make it possible toestimate production levels in the coming years. The projected improvement inprices would in the near future cause the companies to attempt to utilize asmuch of current capacity as possible, and to undertake the designated (miningand leaching) investments. Based on the predictions of each company as tolikely levels of technically feasible production, adjusted to reflect themission's judgment as to the time when new facilities will actually be opera-tional and as to necessary minor revisions in likely capacities at oldermines, production would rise at a rate of approximately 1.0% per annum between1976 and 1983, when production of finished copper could reach about 760,000tons. This assumes, however, that the decrease in labor productivity (otherthan that caused by declining reserve grades and mine depth) is halted beforeit further erodes effective production capacity, that operating facilities areproperly maintained and that reasonable price levels can be obtained in orderto allow necessary capital to be raised. As the most easily mined reserves atcurrently operating mines are depleted further and the net increase providedby new investment begins to serve merely to replace much of the lost output ofolder mines, however, production beyond 1983 could the:. begin to declineslightly, at an annual rate of perhaps 1%, unless new development projectswere undertaken in the final TINDP years. The implementation of these projectscannot be foreseen currently, but could well be called for based on actual andexpected price trends, technical couditions in the industry and governmentpolicy at the time. In the short term, however, the Zambian Government andmining companies will have to work together to see that the sector' s cur-rentpotential Is realized and that the forecasted short-term growth actually takesplace. This is something wnich is subject to certain influences (prices,investment climate, transport, avoidance of natural disaster) which cannot befully controlled, but the prospective profitability of the sector makes thenecessary efforts worth Government's coutinued careful attention.

CHAPEER II. ORGANIZATION OF IHE MINLNG INDUSTRY

A. Mator ODerating Entities

2.01 The great majority of Zambia's mining operations are located inthe "Copperbelt", an area of some 7,700 square kilometers in the north-central area of the country, bordering on Zaire. These operations are dom-inated by two major companies, Nchanga Consolidated Copper Mines Limited(NCCM) and Roan Consolidated Hines Limited (RCM). Both of these companies,comprising formerly foreign-dominated mining groups, took their present formin 1970, when the Goverument acquired 51% equity ownership in each in returnfor the issue of six percent bonds, denominated in dollars with a total parvalue of $269.5 million. The majority shares of the miaing companies' issuedcapital are held by the parastatal Zambia Industrial and Mining CorporationLimited (Z=%CO). According to the original takeover agreement, the minority

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shareholders continued to run the mining operations under management, con-sultancy and marketing contracts which gave them considerable freedom inday-to-day operations as well as substantial influence on investment andfinancial decisions. These contracts were terminated in late 1974 and early1975, after the compensation bonds were redeemed in full, and Zambian managingdirectors of NCCM and ERCM were appointed, although many high-level financialand technical staff formerly employed by the minority shareholders were re-tained. A local company, the Metal Marketing Corporation of Zambia Limited(MEMACO), was established in 1973 as the sole marketing agent for all metalsand minerals produced in Zambia.

2.02 While the two major operating companies hold long-term leases overtheir active Copperbelt: mines and a number of other deposits which it hasnot yet been economically feasible to develop, exploration in most otherareas is done by MINDECO Limited, a fully-owned subsidiary of Z1IMCO, eitheralone (through its MINDEX department) or in partnership with various foreignprospecting and development firms such as Geomin of Romania and Noranda MinesLimited of Canada. In addition to its mineral exploration and developmentprojects, MINDECO is also responsible for the development and operation ofsmall mines and processing facilities designed to serve domestic industrialusers, and for the operation of Maamba Collieries Limited, Zambia's principalcoal producer.

B. The Role of Government in Mining Operations

2.03 The Zambian Government affects the course of events in the miningsector as majority shareholder in RCM and NCGM as well as through the numerousother channels of impact it has as the government of the country in which themines operate. It is not always easy (and may not be significant) to separatethese influences, in part because Goverament does not act through a singleministry in its dealings with the mining sector. For example, governmentrevenues from the minirng sector are raised both through a series of taxes andany dividend earnings t:hat may be declared. The mix of methods chosen affectsthe companies' financial positions, their capital expenditure plans and theirattractiveness to foreign lenders. Yet there seems to be only scant policycoordination between the Ministry of Finance, which is responsible for taxrates, and the-Ministry of Mines and Industry, 1/ which through its presenceon the companies' directorates (the Minister is Chairman of the Board ofDirectors of both minirng companies) affects dividends policy.

2.04 In addition to its impact on the amount of resources available tofinance capital expendi.ture, the Government has also influenced the miningsector in determining t:he pattern of such expenditures and other aspects ofdevelopment policy. Th.is influence derives in part from the Government'smajority ownership, which gives it a determining voice as regards the location

1/ In April 1977, thi.s ministry was divided into two separate ministries.

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and magnitude of major new investments, and also from other policies adoptedby Government, as both shareholder and regulator (e.g., through mines inspec-tion and licensiag). Among these policies are: (a) continuing operations atcertain m.ines to maintain employment opportunities and the economic health ofthe surrounding communitiea; and (b) attempting to ensure that as much ore ascan safely be extracted from opened stopes is taken, although the grade ofcertain portions of the ore may be relatively low. These policies, which anygovernment might adopt in line with particular national development andresource conservation plans, may have the effect of raising current operatingcosts. They also have the effect of encouraging the industry to develop newand lower-cost operations, although investment planning may be somewhatconstrained by such Government actions.

2.05 The lack of a clear direction in Government sectoral strategymakes it difficult to assess the optimality of mining development and ex-ploitation policies. The maximization of current revenues is stressed asthe major seccoral goal by many in Government who foresee a gradual phasingout of mining activities over the next two decades in the face of heightenedinternational competition among suppliers and greater interaal economicdiversification, while others stress the need to "conserve" mineral resources(by extracting lower ore grades, for example), at the cost of reduced revenuesin the short run. Both of these goals appeared in the Second National De-velopment Plan (1972-76), but it is difficult to determine the relativeimportance Government assigns to each.

C1AFPTE III. SECTORAL POLICIES AND RECENT PERFORMAINCE

A. The Second National Development Plan (SNDP)

3.01 The role of copper production and sales as the backbone of theZambian economy and the principal source of foreign exchange was recognizedin the SNDP, which covered the period 1972-76. The averall economic growthrate depends to a large extent on progress in the mining sector, the grossoutput of which was forecast in the SNDP to increase at an annual rate of6.6X, with copper production projected to rise at 6.82 p.a., from 645,000metric tons in 1971 to 900,000 tons in 1976. This forecast, prepared by thedevelopment planning unit in conjunction with the mining companies, assumed anaverage copper price of K 740 per ton f.o.b. (52i/lb), 1/ capital expendituresof approximately K 375 million (in constant 1969 prices) and ouly minimAlincreases in the size of the labor force.

1/ Presumably in current prices. In actuality, prices averaged 68.5 i/lbin current prices but only 50.7 i/lb in constant 1972 prices over thisperiod. The fluctuations were extreme, however, due to the 1973-74boom and subsequent recession, which nad negative investment and pro-duction effects (see paragraph 3.03 (ili)).

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3.02 The SNDP did not detail the underlying capital expenditure programby project or year. Expenditure 1/ over the entire SNDP period was sched-uled to amount to approximately K 184 million for maintenance of copperproduction capacity (including replacement costs) and K 191 million forexpansion of productioo. capacity, with additional funds set aside for pros-pecting, exploration, research, and possible developments outside the majorcompanies. Restoration and/or expansion of production was generally expectedto take place at Mufulira, Rokana and Chambishi mines, with major new develop-ment projects scheduled at Chingola (Tailings Leach Plant, Stage II), Baluba,Bwana Mkubwa and Kansanshi.

B. Sect.oral Performance in the SNDP Period

3.03 Production of finished copper increased in the 1972-76 period at anaverage annual rate of less than 0.4%. The lowest production recorded was in1975 (640,300 tons); the highest was 712,900 tons in 1976.

Table 3.1 ZAMBL..N PRODUCTION AND EXPORTS OF COPPER, 1970-1976

'000 Metric Tons of '000 Metric TonsYear Finished Copper Exported

1970 683.3 684.01971 633.5 635.01972 698.0 711.01973 681.2 670.01974 702.1 673.41975 640.3 641.21976 712.9 711.0*

*EstimateSource: CSO, "Selected Economic Indicators," January 1977

(mimeo) and Monthly Digest of Statistics, February 1977.

The three instances of annual declines in production and exports in 1971, 1973and 1975 can be attributed to specific factors, which also contributed to thegeneral failure to increase production appreciably over the entire period: 2/

1/ In 1969 prices.

2/ One factor which had notably little impact on production levels wasZambia's participa.tion in the Intergovernmental Council of Copper Export-ing Countries (CIP'EC). Although export limitations were supposed to beset as from 1974, the need for revenues by exporters (including Zambia)as prices fell dramatically caused member countries not to heed theirvoluntary export cquotas. This situation is likely to continue (seeparagraph 5.27).

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(i) the Mufulira mine disaster of September, 1970, which causedproduction there to drop from a total of 173,600 tons ofcopper (in concentrates) in 1969 to 126,300 tons in 1970and 80,200 tons in 1971 1/;

(ii) the Rhodesian border closing of 1973 and later transportproblems (especially the closing of the Benguela railwaythrough Angola in 1975 and subsequent Dar es Salaam portcongestion), which accounted for delays in shipping, short-ages of vital imports and loss of export revenues; 2/

(iii) the extreme downswing in world copper prices in 1975 (down40% from 1974), following the unprecedented boom (up 73%from 1973 to 1974) the previous year, which discouragedproduction, prevented recovery from the above-mentionedfactors, and caused newly begun projects to be cut back;the fall in profits 3/ and the worsening investment climatealso appeared to reduce the level of capital expenditures.

3.04 In addition to these unforeseen events and their aftermath, severalother factors must be taken into account in explaining the overall failureto make any appreciable progress toward raising finished copper productionto the targeted total of 900,000 tons during the SNDP period. The first ofthese is that the production target was simply unrealistic from the beginning.The SNDP was prepared in an atmosphere of general economic optimism, in whichthe mining sector was expected to increase greatly its contributions asZambia's primary source of public revenue and foreign exchange. The forecastof 900,000 tons production in 1976 did not adequately account for any contin-gencies or major cyclical movements, and was based on the "maximum possible"levels of (full-capacity) production as conceived by the mining companies in1971.

1/ Despite considerable rehabilitation work at Mufulira that was carriedon through 1974, when 143,900 tons of copper in concentrates wereproduced, it is thought unlikely that the pre-1970 production level(173,600 tons in 1969) could again be reached.

2/ In 1975, the copper companies were for a while obliged to declareforce maleure on up to 40% of their contractual shipments becauseof transport difficulties. These obligations were subsequently met,but several thousand tons of finished copper bound to Angola's Lobitoport for export were trapped on the Benguela Railroad and never recovered.

3/ Combined before-tax profits reported by the mining companies fell from K356 million in their 1973-74 fiscal year to K 169 million in 1974-75.Together, the companies posted a loss of K 54 million in 1975-76. Thedevaluation of the Kwacha in June 1976, has had an imnortant effect onche companies' profitablilicy thais year (see paragraph 5.20); adjustingfor extraordinary itePm (i.e., devaluation losses on long-term debt),pre-tax profits are expected to be K 128 million for the 1976-77 fiscalyear.

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3.05 Major technical and financial setbacks were the most important

causes of stagnation in copper production. While it is not possible hereto undertake a technical review of operations at each mine over the period,problems arising in certain mines at which greater progress was expected

account for much of the lack of net expansion. At Mufulira, for example,mine rehabilitation tock longer than expected and plans for subsequent ex-

pansion proved technically infeasible. After two years of greatly reducedproduction following the disaster (1971-72), annual copper production atMufulira reached a plateau of about 120-130,000 tons, more than 20% below the

pre-disaster level. Plans to increase production at Konkola mine (originally

projected to reach 100,000 tons by 1980) were thwarted by serious dewatering

problems so that production stagnated at the 50,000-tons level. Major invest-ments were also made in. expanding Konkola's treatment capacity, but theexpected transport of additional ore from Chingola did not materialize because

of the inadequacy of the Konkola plant to treat the Chingola ores (due totheir mineralization characteristics) and due also to increasing transport

costs. The expected increases in production which did materialize at Chambishi,the Chingola leach plant, Bwana Mkubwa and Baluba were sufficient only to

maintain production and not to contribute to any net expansion.

3.06 Capital expenditure plans for the SNDP period went awry not only

because of technical problems such as those described above, but also because

the low profitability (see paragraph 3.03 (iii)) and lack of outside financefor expansion in the second half of the period severely reduced the level of

real expenditures. Actual capital expenditures (in 1969 prices) totalledonly K 320 million, 1/ 15% below the forecast amount, which would have been

reached had capital expenditures continued at the levels reached in thefirst two years of the SNDP period.

1/ The Mission has had to estimate the level and composition of capitalexpenditures on the basis of company accounts, which treat the datainconsistently. Changing regulations regarding the tax treatment of

capital expenditures caused variations to occur, particularly withregard to the treatment of replacement costs, with neither of themining companies nor the Central Statistics Office using con-sistent definitions in their reporting. Replacement expenditures are,

however, generally included in capital expenditures as reported over

the SNDP period.

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Table 3.2: CAPITAL EX2EIDITURE BY ZAMBT1.N MINING COMPANIES, 1972-1976

K million K millionYear Current Prices Constant 1969 Prices*

1972 84.7 76.31973 87.1 76.41974 95.7 68.41975 96.0 59.61976 71.6 39.6

Total 435.1 320.3

*Deflator: Implicit deflator of gross capital formation in nationalaccounts, CSO.

Source: Mining Companies' Annual Reports, Mission Estimates.

3.07 As a result of reduced capital availability and lower price pros-pects, the Kansanshi mine, a major new project expected to begin operating inthe Plan period, was postponed indefinitely, after some K 9 million had alread3been invested in exploration and infrastucture development. Other new devel-opment projects which were expected to start operating at the end of the SNDPyears or soon thereater (e.g., Baluba, Kalulushi East) were also postponedbecause of capital shortages.

3.08 While coutinually changing accounting practices make it difficultto assess whether expenditures at active mines went to finance renewal and re-placement-facilities to maintain production at or near ongoing operations(e.g., hoist repairs, compressor/transformer replacement, shaft deepening,smelter/concentrator overhauls) or major new developments (e.g., the wholeBaluba mine operation at the Luanshya division), it appear that a growingpercentage of expenditures was going to maintain operations in the lateryears of SNDP, especially when greatly reduced profitability caused thecompanies to focus their spending on maintenance. Although real capitalexpenditures were almost double the amount projected as necessary for replace-ment, the amount of capital expenditure required to maintain production levelsappears to have been underestimated for two reasons:

(i) many types of equipment replacement, which prior to S10Phad been categorized as operating expenditures but whichduring much of the SNDP period were considered as capitalexpenditures were not included in the forecasted capitalbudget; and

(ii) the decline in output at older mining operations was notadequately foreseen; hence investments which were supoosedto contribute to a net expansion of output merel7 reolaceddeclining production in otner operations.

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3.09 One further factor which adversely affected production was a seriousmanpower constraint, exacerbated by shortages of critical spare parts. Al-though the labor force in the mining companies increased at a rate of 2-37annually, compared with the constant level of employment projected in the SNDP,output did not increase. This decline in labor productivity was due to threereasons, in addition to the geological necessity of producing more ore perunit of finished copper:

(i) an increase in the relative share of overhead labor;

(ii) greater turnover of expatriate labor (with a conse-quent decline in the average level of experience); and

(iii) greater amounts of breakdown time due to shortages ofimported spares and delays in their transport to plant.

The reduction in effective labor resources not only inhibited production atongoing operations, but also prevented the realization of projects designedto increase production capacity, ranging from vital training programs to aninability to make use of expanded potential capacity (of up to 65,000 tons)at Rokana smelter.

CHAI`TER IV: CURRENT OPERATING CONDITIONS

4.01 One of the major determinants of long-run copper production trendsis the current, and expected future, level of world market (L.M.E.) prices.Current price fluctuations affect profitability and, in part, the availabilityof funds to invest in facilities for future production. Expected futureprice trends affect malnagement decisions as to ongoing operations (e.g., howfast to deplete natural resources) and investment plans to allow for desiredlevels of future production. The enormous size and complexity of Zambia'smining industry, however, make major production-changes difficult toaccomplish in short periods of time and require the tying up of large sumsof capital investments that are risky, given the volatility and short-rununpredictability of copper prices. While these price movements have importantconsequences for Zambia's economic well-being and its prospects 'or growth,the general level of production can best be explained by a number of importantsupply-side factors: available reserves, installed production capacities andlevels of unit production costs. This chapter reviews recent developments andthe current situation regarding these factors which affect present productionlevels. Chapter V will consider likely future trends among these factorswhich, together with expected price movements and assumed government policies,will allow projections of future mining industry output to be made.

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A. Reserves

4.02 In situ ore reserves in the Copperbelt at the end of 1975 totaled860 million metric tons at a grade of 3.06Z (26.3 million tons of containedcopper, or some 20 years' worth of reserves at expected production and re-covery rates). 1/ In addition to these deposits, significant quantities ofcopper are found in "tailings", the stockpiled residues from past processingof ores, which can be fed directly into the leach plant and then electro-won(see paragraph 4.06).

4.03 Sufficient quantities of in situ ore reserves are "fully developed"to assure that production levels can be maintained for a period of some ninemonths, which is only about one-half the level in Zambian mines about tenyears ago. 2/ "Partly developed" reserves, if eventually developed further,could allow for production levels to be maintained another two years or so.The pace of development (which is usually measured in amount of bench materialprepared, meters of shafts sunk, tunnelling, stope preparation, etc.), whichhad quickened in the early 1970s to keep pace with production, slowed in 1975and apparently in 1976. A return to the situation which prevailed prior to1972, in which the number of meters developed was at least constant in relationto the tonnage of ore extracted (and thereby allowing production to be main-tained for a period of 3-5 years into the future, according to an industryrule of thumb), will depend on factors such as price and production prospects,the availability of skilled personnel, etc., which have caused the level ofdevelopment work relative to production to decline in recent years. Whilethis decline has not been dramatic, if it were to continue, it could eventuallybecome difficult to maintain the current pace of, or to expand, production.

4.04 Ore reserves are not static, but change each year as mining pro-gresses (causing depletion) and as drilling may delineate additional reserves.Following is a summary of annual reserve levels at active Copperbelt mines.While in each year additional ore reserves are located by drilling, the selec-tive mining of higher-grade portions of the reserves has caused the grade ofthe remaining reserves to decline, which accounts for the fluctuation in tonsof contained copper reserves. The decreasing grade of reserves is a majorsource of mining cost increases, as is discussed below (paragraph 4.12).

1/ Mine life is estimated on the basis of an historical overall recoveryrate of 85Z and average annual production of 750,000 tons of finishedcopper, including that recovered by the leaching of old tailings.

2/ The level of reserves development refers to the volume of excavationcompleted in relation to the amount necessary to prepare for the actualblastiag, mining and hoisting of ore. "Fully developed" reserves arethose for which 90% of the required development volume has been openedup, "partly developed" reserves are those for which from 50% to 90% ofdevelopment is completed, and "oossible" reserves are those proven bydr4 lling olerarions but for wt.ich little deveiooment work has actual!.-taken place.

Table 4.1: Development In Copperbelt Mlnes, 1970-75---------(METERS/YEAR)-----------------

Ratio:Underground Meters

Main Drives Ore Development/Shaft and Stope TOTAL Production Tons of

Year Sinking Crosscuts Preparation Misc. DEVELOPMENT ('000 tons) Production

1970 728 37,674 244,743 23,789 3o6,934 22,98u .0134

1971 660 40,942 247,062 21,294 309,958 21,803 .0142

1972 557 36,300 274,058 17,926 328,841 23,187 .0142

1973 601 36,731 266,977 23,178 327,487 25,288 .0130

1974 521 40,014 269,505 21,186 331,226 26,143 .0127

1975 675 31,977 244,360 12,477 289,489 24,479 .0118

Source: Mining Yearbooks and Mining Companies' Annual Reports.

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Table 4.2: ORE RESERVES AT COPPERBELT OPERATIONS, 1969-75

Year End Tons of Ore Cu Grade In Situ Tons Contained Cu

1969 753,115,000 3.33 25,078,7301970 775,840,000 3.27 25,369,9701971 796,667,000 3.28 26,130,6801972 808,535,000 3.21 25,953,9661973 841,081,000 3.13 26,325,9851974 832,636,000 3.10 25,811,7161975 859,274,000 3.06 26,293,784

Source: Mining Companies' Aanual Reports.

B. Production Capacities

4.05 The production of copper in Zambia is a highly complex amalgam ofdifferent processing methods at various Copperbelt operations. The level atwhich the various processes are used depend on:

(i) the mineral content of available inputs (oxide or sulphidecopper ores, or dumped tailings produced by previous pro-cessing of ore);

(ii) the effective capacity of the various processing units(including considerations of technological constraints,persounel requirements, accessibility, etc); and

(iii) the desired output (i.e., refined shapes/wirebars orcathodes).

For the purpose of identifying and untderstanding possible production con-straints and estimating future production levels (see Chapter VI) a simpli-fied material flow diagram of the ways in which copper is produced is shownon the following page. It should be remembered that there are several waysin which finished copper is produced and that, while certain directions offlow are determined by the physical characteristics of the materials beingtreated, the particular paths through which materials pass as they are pro-cessed into finAl products are to some extent determined by managementdecision. These decisions may vary over time and depend on such factors asthe location at various times of ores and processors (only certain processingunits are installed at individual mining complexes and the output of some isoften treated partiall7 or completely at other locations), the relative cost-efficiency, recovery potential and capacities of the different processingunits.

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- 18 -

Nature of Invuts

4.06 The primary feed into the processing system is copper ore extractedby either underground or open-pit mining methods. The share of productionattributable to (generally less expensive) open-pit mining has for severalyears been relatively constant at about 30% of ore brought to the surface,and between 30-40% of contained copper. An alternative method, the reclama-tion and leaching of old tailings, is a relatively new and thus far minoroperation (only 1,200 tons of contained copper in reclaimed tailings weretreated at Chingola in the first twelve months of operation in 1975-76).

4.07 Copperbelt deposits which feed into the processing system consti-tute a mixture of "sulphide" minerals (chalcopyrite, chalcocite, and bornite)and "oxide" minerals (predominantly cuprite, malachite and azurite). Thisdistinction has important operational. implications for processing, becauseof the need to treat the (generally acid soluble) oxide ores differentlythan the (non-acid soluble) sulphide ores. As a result, investment and pro-duction must be carefully managed to insure the best mix of metallurgicalequipment is available, considering relative costs, location and availabil-ities of the different ores, complementarity with existing equipment and thedpmand for various forms of finished product (e.g., cathodes, wirebars).Oxide ores, which now represent about 25% of contained copper processed,have accounted for a slightly diminishing percentage of contained copperover time because of the deepening of Copperbelt operations in recent years(copper oxide minerals tend to predominate in the upper, near-surface zonesof a given deposit, and are usually mined first).

Effective Production Capacities

4.08 The mission has reviewed mining company estimates and plans regard-ing production capacities, in order to identify possible constraints, currentinvestment needs, the impact of parts and personnel. scarcities and probablelevels of future production. "Effective production capacity" is an elusiveconcept, both in general and in the Zambian case, however, for several reasons.Significant among these is that varying and often unpredictable ore grades andrecovery rates make it difficult to relate directly quantities of materialsprocessed or produced to levels of finished copper production; discussion ofcapacities in terms of finished product or other suitable common denominatorsis therefore difficult. Nor are these indicators (grades and recoveries)determined solely by fixed geological or technological limits; the marketprice of copper can cause producers themselves to alter grades or recoveryrates within a certain range. I/ Also in the case of Zambia, notional produc-tion capacities based on presumed optimal operating conditions may over-estimate effective capacity because of possible shortages in vital spare partsand skilled labor needed to keep the equipment running.

1/ in mining, for example, the ore grade can be temporar.lv increasedbv selecr've aining of higher grade ores (thereby deplating reservesfaster). In concentrating, manipulation o. ore feed races can affectrecovery; after a certain point, increasing the rate of feed causesreduced recovery.

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4.09 At present, tlo single copper production element is causing seriousbottlenecks that cannot: be handled by improved maintenance and operationactivities or occasional "re-routing" of materials through a more efficientprocessing flow. Currently established ore production capacity (i.e., extract-able amounts from underground aad open-pit mines) is estimated at 40 milliontons per year (960,000 tons of contained copper if a grade of 2.4% is main-tained), compared with 35 million tons actually produced (840,000 tons ofcontained copper) in 1976. Flotation plants (concentrators) have the capa-city to treat some 36.5 million tons of ore with an average recovery rate of85% (or 714,000 tons of: contained copper). Roasters can treat some 200,000tons of concentrate per year (approximately 50,000 tons of contained copper).Total smelter capacity is estimated at 575,000 tons of finished copper peryear, but this figure is particularly sensitive to the availability of spareparts and of skilled personnel to maintain and operate the smelter. Therefineries can produce some 680,000 tons of wirebars if the smelter providessufficient anode feed. Current electro-winning capacity is 117,500 tonsfinished copper/year from high-grade leach operations, and 85,000 tons fromlow-grade leach operatLons.

C. Production Costs

4.10 Direct production costs (mining and processing operations, throughthe refining stage, including mine administrative costs) are estimated to haverisen over the SNDP period at an average 11.3% p.a., from K 410 to K 700per tons of finished copper f.o.r. (free on rail at mine). 1/ The level ofindirect operating expenses (company administration at headquarters, centralservice bureaus, etc., marketing costs and interest charges) has averagedbetween one-quarter andi one-third of that of direct production costs, risingfrom K 108 to K 243 per ton in the last Plan period.

1/ The problem of quantifying operating costs is as difficult as measuringcapital expenditures (see note to paragraph 3.06), because the distinc-tion between them is blurred. Estimates of direct and indirect operat-ing costs, as defined in the text, were therefore developed by themission from a wide range of company accounts, but while very approximatethey are still indicative of the industry's cost levels and structure.For similar reasons of inconsistent accounting practices, however, it isnot possible to compare current average Zambian operating costs directlywith those of other countries.

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Table 4.3 AVERAGE PRODUCTION COSTS PER TON OF FINISHEDCOPPER LI COPPERBELT, 1970-1/1975-6

(In Current Kwacha)

AnnualGrowth

1970-1 1975-6 Rate

Direct Costs (f.o.r. mine) 410 700 11.3%

Indirect CostsMarketing (Transport to Port,

Freight and Insurance, SalesCommissions) 82 110 6.1%

Administration and Miscellaneous 22 93 33.0%Finance Charges 4 50 65.0%

Subtotal 108 243 17.6%

Total Costs 518 943 12.7%

Source: Company Annual Reports, Mission Estimates.

Direct Costs

4.11 The increase in direct costs has been relatively steady, attri-butable mostly to the declining grade of ore fed to the mills, and the con-sequent increase in ore production requirements. Other elements affectingthese production costs have been the rise in general mine expenses due to thesubstantial rise in the cost of spare parts and other stores, the decline inlabor productivity at the mines and reduced production levels against which tocharge mine overhead expenses. The mission concludes that real productioncosts have been rising at an average annual rate of approximately 2.7% in the1970-1976 period, constituted as follows:

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Growth inReal Unit Production CostAttributable to Element

(a) Increasing Ore Productionand Concentration 1/Requirements and Costs 1.8%

(Extraction) (1.6%)(Concentrating) (0.2%)

(b) Declining Labor Productivity 0.5%(Other than that relatedto decreasing reservegrade or hoisting)

(c) Increasing Cost ofSpares and Stores 0.4%

Total 2.7%

(a) Increasing Ore Production Requirements and Costs

4.12 As mining costs represent about 50% of the total cost of producingeach ton of finished copper, and are also sensitive to the steady depletion ofeasily accessible reserves, it is natural that they also represent the largestshare of forces causing increasing real unit production costs. There are twoelements to this rise ..n costs: (i) the need to exact more tons of ore, and(ii) the increased unit cost of producing each additional ton at the margin.

4.13 The major source of real cost increase has been the need to extractfrom underground mines or open pit operations additional tons of ore in orderto obtain each ton of finished copper processed from mined ore (i.e., excludingfinished copper obtained through solvent extraction of tailings previouslymined and treated ores). The most signficant contributing factor in thisregard is the steadily decreasing grade of reserves in situ (see paragraph4.04), which can be expected to continue in the absence of changes in extrac-tion selection policies. In addition, dilution, i.e., the mixing of wasterock with ore due, inter alia, to "contamination" resulting from geological

1/ As additional ton:a of ore production also represent an added concentratingcost, discussion of additional extraction requirements throughout thissection reflects trends in concentrating costs as well. From the selecteddetailed cost information available on concentrating, the Missionassumes that these represent approximately 0.2% annual growth in realunit production costs of finished copper. This is much smaller thanthe cost increment represented by additional extraction requirements,because concentrating represents no more than one-half the share of totalcosts accounted for by ore production, and because increasing recoverybeing accomplished in concentrators compensates in part for the processingof additional material, so that there is not a proportional rise inconcentrating costs for each additional ton of ore produced and treated.

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pressures caused by unavoidable hanging wall conditions or to less effectivesupervision of mine laborers, has also caused ore production requirements toincrease in certain mines. The overall dilution average of Copperbelt mineshas been somewhat cyclical, however, because of the changing balance ofconditions faced in newer and older mines and shafts. 1/ While there has beena slight trend in recent years towards increasing dilution (confirmed duringconversations with managers at the mines) it is hazardous to estimate futuredilution trends and their cost implications on this basis alone.

4.14 The quantity of ore produced per ton of finished copper rose atan annual rate of 3.5% between 1969-75, as follows:

Table 4.4 ORE PRODUCED PER TON FINISHED COPPERPRODUCTION, /a 1969-1975

(In tons)

1969 43.111970 47.151971 48.301972 48.321973 51.261974 50.671975 52.96

/a Total ore extracted from underground and openpit operations divided by total productionof finished copper from all sources.

Source: Mining Yearbooks

This increaase reflects both reserve grade diminution and all other factors(e.g., dilution). The rate would have been greater, had tailings leachoperations to re-treat formerly mined material not begun in recenr years.

4.15 The actual impact of increasing extraction requirements on produc-tion costs depends also on the cost of producing each ton of ore, which inturn is partially a function of the relative shares of ore extracted by under-ground and open-pit mining, and partially a function of the increasing real

1/ There are instances of cyclical dilution rates caused by forces otherthan the mere aging of mines being periodically offset by the bringinginto operation of newer mines. For example, a single mine that isaging may at times experience stages of declining dilution as a shaftis deepened, as less "contamination" would be exserienced at a deeperlocation nearer the shaft than at previously mined areas at lesser depthsbut farther from the main shaft.

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unit cost of both operatLons. 1/ In addition to the need to produce more tonsof ore, in fact, each toll produced has required additional inputs of mininglabor and materials. Ali:hough it is difficult to quantify the share of eachof the various factors contributing to the rising costs based on availabledata, a major portion is certainly attributable to decreasing labor produc-tivity 2/ (see paragraph 4.17ff) and, to a lesser extent, to increasingventilation and drainage requirements as the ore produced is obtained fromgreater depths and wider areas.

4.16 Taking into account both the need to produce additional tons of oreand the increasing real unit cost of doing so, the average annual cost incre-ment in extraction necessary to produce a ton of finished copper is estimatedat K 5.75 (in 1969 prices) between 1969 and 1975. This increment by itselfrepresents an average 1.6% compounded annual increase in production costs perton of finished copper. It is estimated that approximately K 4.50 of theaverage annual cost increase (or 1.3% of the compounded annual increase inunit production costs) is attributable to the need to produce additional tonsof ore. The total increment, including additional concentrating costs (seenote, para 4.11) and increasing unit costs of ore production, is estimated at1.8%.

(b) Declining Labor ProductivitY

4.17 A second elemeat in rising real production costs has been the steadydecrease recorded in the productivity of mining company labor (measured overall employees). A portion of this impact has already been included in themeasure of increased ore production costs above, in terms of the extra laborneeded to produce a ton of finished copper due to both falling reserve gradesand the need for additional labor to hoist one ton of ore. It is the latteritem, accounting for perhaps 0.25% annual growth in real unit productioncosts, 3/ which is attributable directly to labor productivity and utilization.

1/ It should be noted that ongoing research and experimentation withnew mining methods may well cause future real cost conditions forextraction to vary. The Mission was unable to give this possibilityin-depth attention, however, so that future cost trends are esti-mated on the assumption that mining methods remain the same.

2/ Labor productivity may in fact not only account for increased realcosts of producing ore but, to the extent that less productive labor(due to inadequate supervision, for example) is also responsible forthe hoisting of additional waste rock in relation to ore, can alsobe affecting the grade of material reaching the concentrator.

3/ This follows from the assumption that nearly all the increasing unitcosts of ore production, shown in paragraph 4.16 to account for about0.3% of compounded annual growth, are related to the need for additionallabor, because of insufficient supervision, equipment down-time inthe absence of spares, and shorter periods of effective working time dueto the greater period spent in transit to deeper or more distant mininglocations. The remLaining elements of this real cost increase are marginaladditions to pumping or ventilation requirements and to hoisting distances.

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In order to account for labor-related cost increases throughout the copperproduction cycle, it is only possible to take a comprehensive measure ofproductivity loss (such as the increase in manshifts required to produce oneton of contained copper) and then net out those losses already measured inincreasing ore production requirements and costs. Insufficiency of data makesit impossible to measure productivity of miners, managers or other employeesspecifically. The direct impact of declining productivity is most visible inthe trend decrease in tons of ore produced per total manshift, which is notaffected by the declining grade of that ore.

Table 4.5: COPPERBELT LABOR PRODUCTIVITY, 1969-75

ManshiftsRequired

Tons Ore Kgs to ProduceHoisted Contained One Ton

Labor per Copper per ContainedYear Strength Manshift /a Manshift /a Cooeer

1969 48,227 2.25 52.19 19.181970 48,469 2.19 45.45 22.001971 49,748 2.05 42.63 23.461972 50,845 2.22 45.93 21.771973 52,792 2.21 43.11 2.3.201974 57,128 2.10 41.40 24.151975 57,487 1.99 37.56 26.62

/a Manshifts estimated at 300/year per employee.

Source: Mining Yearbooks

4.18 There has been a 40% increase in manshifts required to produce oneton of contained copper, from extraction through refining or electro-winning.This decline in productivity is attributable to several reasons (other thanthe decreasing ore grade):

(i) the greater divergence between "theoretical" and "effective"-a-shifts 1/ due to increasing downtime resulting frominsufficient spare parts and other causes of extendedmachinery breakdowns and to the increasing amount of timespent in travelling to and from deeper deposits;

1/ 'T heoretical" manshifts refer to those for which a worker reports forduty; "effective" manshifts are the measure of time spent in directlyproductive activity. As additional time is spent in other ways (e.g.,waiting for machine repairs, travelling deeper underground, etc.), thedivergence between theoretical and effective manshifts grows. As isobvious, some of the causes of this greater divergence are the resultof natural mining conditions and some are attributable to man-madecauses.

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(ii) the growing turnover, lesser experience level and often per-sistent vacancies 1/ on mining company staffs (see Table4.6), particularly among key expatriates in supervisoryand training positions, artisan work needed to maintainequipment and other important technical jobs in miningand especially in copper processing; and

(iii) the rapid grourth of the relative share of overhead per-sonnel included in these calculations (refer also tosection paragraph 4.24, which documents the risingshare of indirect-including company administrative--costs).

4.19 Taken by itself, the additional wage bill per unit of productionarising from all causes could represent up to an average 1% annual increasein real costs. Because a good part of these costs have already been accountedfor elsewhere, however, the mission estimates that approximately 0.5% growthin costs can be attributed to productivity decreases not otherwise taken intoaccount.

(c) Cost of Inventories

4.20 The last major element of real cost increases relates to the needto maintain much greater levels of (increasingly expensive) spare parts andother stores to continue operations. These needs have arisen from the in-creasing lead-time required to order spares and greater uncertainty as to thetime required for shipment. 2/

4.21 The most important factor contributing to these trends has been theloss of most reliable transport facilities to African ports, first because ofthe Rhodesian border closing in 1973 (blocking the rail route to Beira) andthen the loss of the Lobito route, due to the continued unrest in Angolasince 1975, leaving Dar es Salaam as the only available large-scale portfacility. 3/ This routel, too, has been of variable usefulness, due to intermit-tent port congestion and inefficiency. The road transport that had to be usedto and from Dar es Salaam until recently was quite reliable (taking 5-6 days)

1/ One company reports a 16% net loss in expatriate personnel in theeleven months prior to February, 1977.

2/ The increasing size of inventories also involves a substantial rise infinance charges, which is reflected as part of the upward trend in in-direct costs generally.

3/ A related problem arising from transport problems is the increasingstocks of finished metals. In the second six months of 1976 alone,mine stocks rose from just over 3,000 tons to nearly 20,000 tons, re-presenting the tying up of an additional K 17 million (at 1976 prices).The influential factor as far as production costs are concerned is stillthe increase in co3t of stores, however; the delay in shipment of finishedmetals causes a strain on cash flow and the need for obtaining specialfinancing arrangements, but does not contribute to the total increase indirect unit production costs.

Table 4.6; COPPEIDELT LA8f)R FORCE, TUflNOVER A"D AVERAG.E LEtNGTII OF SERVICE, 1969-75

Hun.ber Annual Average Length of Service (Percentage)Average HurnNbr Left Turnover

Year Strength Engad Service fPercentage) 0-5 Years 5-10 Years 11-15 Years 16-20 Years Over 20 Years

Expatrlate Emiployees

1969 4,727 947 1,227 25.96 66.44 18.03 7.89 4.87 2.771970 4,i75 1.162 1,092 24.96 69.14 14.95 7.61 4.80 3.501971 4.751 1,043 1,121 23.60 69.09 14.75 7.78 5.13 3.241972 4,60a l,o8) 1,139 24.76 68.92 15.65 6.91 5.14 3,381973 4.5u5 )1059 1.209 26.84 69.45 15.58 6.66 4.47 3.851974 4,392 1,46 1,035 23.56 68.8o 15.85 6.87 4.23 4.3415 , 4Y5 1,018 1,255 27.91 67.37 17.45 6.56 3.35 5.27

Local Euilpoyeeb-

1969 43,500 3,464 2,763 6.35 28.03 31.83 19.86 13.06 6.221970 44,094 3,219 2,175 4.93 27.26 29.10 23.31 11-95 8.391971 44,997 4.431 4,125 9.17 24.33 28.24 26.06 12.72 8.741972 46.245 5,904 3,932 8.50 28.86 23.78 26.16 12.06 9.141913 418,287 6,056 3,607 7.47 31.40 21.20 25.25 12.03 10.131974 51,736 7.431 4,527 8.75 34-95 17.26 22.17 13.07 12.511975 52.992 4,031 4,811 9.07 34.88 16.49 20.83 11.34 16.46

Soiarce; Hlaaing YeiqrbooIs.

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and not too expensive (about K 46 per ton) ; the opening of TAZARA has thusfar decreased inland shipping costs only slightly but at times doubles theshipping time (due especially to technical problems being encountered in itsearly operational stages). 1/

4.22 Stores have also increased as a result of Government's policy todiscourage importation of non-essential goods from South Africa, also resultinggenerally in higher prices of supplies. This policy has caused the companiesto purchase equipment from more distant sources (e.g., Australia), adding tothe extended lead-time for orders as well as to their expense. The shift awayfrom South Africa as supplier has also required some "retooling" expenses,maintenance of certain "dual" spares for similar types of equipment (fromdifferent sources), and the loss of cost savings that would otherwise haveaccrued with the recent completion of an all-weather road in Botswana capableof reliably handling whatever goods traffic would exist between Zambia andSouth Africa (the road is already in use for transporting necessary equipment).

4.23 An additional cause of both increasing stores and occasional short-ages of particular critical supplies, according to mining company officials,is the general system of exchange allocation and import licensing. Althoughthe mining companies are ostensibly given priority in the issuance of alloca-tions and licenses, long delays are now said to be frequent. Independent localsuppliers, who are not accorded the same priority, are undergoing even moreserious difficulties, which in turn affect the mining companies who are theirmajor customers. As a result, the companies now maintain larger stores ofspares to ensure their availability. When an unstocked item becomes needed,serious delays may still be unavoidable, adversely affecting the productivityof mining company equipment and the workers who use it (see paragraph 5.25).

4.24 As a result of these influences, the real value of stores has beenincreasing since 1970 at an average annual rate of 14%, and the stock of sparesand replacements for many items has increased from an anticipated six months'supply to a two-year supply. There is a real increment to production costsrepresented by the additional expenses which accompany the maintenance ofstores. Assuming that these costs represent approximately 10% of the value ofstores, 2/ the cost of stores per ton of finished copper has risen from K 7.90in 1970 to K 14.82 in 1975, which accounts for an approximate 0.4% annualincrease in the real unit cost of producing finished copper.

1/ The mission was informed that, as a result of apparent design mis-specifications, some 300 of TAZARA's 1,100 railroad cars had damagedsteel springs. This has caused derailings and has made TAZARA offi-cials order that the trains move as slow as 30 kmh, or one-half thenormal speed. There are also other management problems at TAZARA dueto delays in obtaining qualified personnel.

2/ This is a conservative estimate by industry standards.

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Table 4.7 VALUE OF MINING COMPANIES' STORES, 1970-75

Average Value of Average Value ofStores, Current Stores, Constant (1970)

Year K millions K millions

1970 50.1 50.11971 54.6 52.31972 57.8 51.51973 87.1 73.51974 129.5 113.61975 149.8 98.6

Source: Companies' Annual Reports, CSO(Deflators) and MissiouEstimates.

Indirect Costs

4.25 Even more striking than the rise in direct production costs havebeen increases in indirect costs (see Table 4.3). In marketing, the transferof nearly all shipments to a crowded Dar es Salaam port after the Rhodesianborder closing and the suspension of services to Lobito since the 1975 hosti-lities in Angola have caused costly delays (see note to paragraph 4.18), andthe worldwide rise in petroleum prices has increased freight cost both toAfrican port and to market. An even greater rise has occurred in interestpayments abroad over the last five years, and especially after the Kwacha wasdevalued in June 1976 (at which time the companies' foreign indebtedness roseinediately by K 39 milliou). This phenomenon is a result of the severe cashflow shortages caused by the precipitous fall in copper prices in 1974-75, thedelays in shipping which required the companies to obtain anticipatory financ-ing on loaded shipments and the need to finance growing replacement andcapital expenditures (many arising out of bold expansion plans launched duringthe previous period of extremely high prices earlier in the SNDP span). Long-and short-term indebtedness of the aining companies, which totalled only K 81million in 1971, was K 399 million in mid-1975. The companies, which hadoriginally expected to finance capital expenditures up to two-thirds throughretained earnings, apparently found that they had to borrow abroad just tomaintain their ongoing operations.

CflA?2. V: DETMIE NANTS OF FUTURE PRODUCTION

5.01 This chapter considers the prospects for evolution of the factorsaffecting production which were detailed in Chapter IV. It also focusesattention on government policies and action, illustrating how these mayaffect production and export levels. On the basis of these factors andprojected world mrket prices, the next chapter estimates likel7 futureproduction levels.

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5.02 Throughout this and the subsequent chapter, world market (L.M.E.)prices are assumed to rise at the rates projected by the IBRD's CommoditiesDivision, Economic Analysis and Projections Department. 1/ These prices arealso used in the main report to estimate future mining revenues, in conjunc-tion with the output levels forecast in Chapter VI of this annex.

A. Reserves

5.03 As indicated in paragraph 4.04 above, reserves at ongoing Copperbeltoperations have remained relatively constant (in terms of contained copper)over recent years, with increasing ore reserves offsetting a fall in averagegrade. Future trends of Copperbelt reserve levels cannot easily be estimated,because of the ambiguous nature of exploration results, the changing economicclimate, 2/ etc. Reserves should continue to be very substantial, in anyevent, given the enormity of current reserves (26.3 million tons of containedcopper) and the new reserves already, or to be, identified beyond currentCopperbelt operations.

5.04 Because it is still uncertain which of these additional known de-posits may become economically extractable, they are not now included in orereserve figures. They are substantial, however, as Table 5.1 on the followingpage shows. Bringing any of the estimated six million tons of containedcopper included, in these deposits into "reserve" status by mine developmentwould require considerable amounts of capital investment. Such developmentwould be especially costly at the rich deposits outside the Copperbelt,because of the need to provide infrastructure (roads, housing, power and waterlines) and perhaps additional processing facilities, because of the distance(and lack of adequate rail transport) to existing Copperbelt smelters andrefineries. Still, if it were decided to increase production very substan-tially in the future in response to more favorable economic conditions, thelevel of ore reserves would not present any serious constraint to increasedproduction. Projects to develop new reserves are already planned or underwayfor Baluba East, Chibuluma East, Kalulushi East and Kansanshi.

1/ Current L.M.E. prices are projected to rise from K 996/ton in 1976 toK-2,091/ton in 1980 and K 3,137/ton in 1985. In constant (1975) prices,these projections amount to K 981/ton in 1976, K 1,542/ton in 1980,and K 1,649/ton in 1985. These prices are converted from $US to K ata rate of K I - $1.265 after June 1976 (prior to June 1976, K 1 = $1.55).

2/ Reserves are quantifiable only in relation to the costs of their extrac-tion and processing and likely market prices.

Table 5.1: SOME CURRENTLY KNOWN DEPOSITS OF COPPER ORE OUTSIDE CURRENT MINING COMPLEXES /a

ContainedEstimated Copper In Expected

Ore Reserves Ore Ore Reserves MiningDeposit ('000 metric tons) Grade (t) ('000 metric tons) Method

(Undergroundor Open Pit)

IN THE COPPERBELTBaluba Fast 13,000 2.5 325 OPChlibulumila East 8,000 6.o-8.o 560 uKalulushi East 10,000 3.0+ 300 U,OP(7)Mokambo 1,200 1.7 20 UHuliasi) 18,000 1.5 270 OPMullashli North 10,000 2.5 250 OPfushiba 4,000 2.5 100 (7)Mwambashil 8,000 3.0+ 24,0 U 0

OUTSIDE TIlE COPPERBELTKansanshI 35,000 2.0+ 700 U,OP

Litinwana 400,000 0.8 3,200 OP

/a All figures are approximate. The lIst, while including most of the largest Identified de-posits, Is not necessarily exhaustive.

Source: RCM, NCCM, MINDECO, MINDECO-NORAIIDA.

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B. Production Capacities

5.05 Given projectecd future world market prices and estimated produc-tion cost trends (see paragraphs 5.12-5.13 following), concerted efforts atthe very minimum to maintain production are clearly warranted. This viewfollows from a forecasted rise in pre-tax operating profits before depre-ciation from K 90/ton to as much as K 765/ton of finished copper between 1977and 1981. 1/

5.06 Based on the m:Lssion's analysis of current production capacities(see paragraphs 4.05-4.0!3), it is believed that certain processing and,particularly, mining facility investments will be necessary in order to permitfuture production to be expanded significantly. Although capacity constraintsin individual processing units may be circumvented for a time by re-routingmaterial to other locations or treating it by a different process, there isa limit to this practice.. The mission believes that the pressing need foradditional smelter capacity in any major attempt to expand production, forexample, cannot be fully met by diverting material to different processors,because:

1/ In current prices. This estimate was made on the basis of prices cur-rently forecasted by IBRD and cost of sales estimates derived in Chapter4 and estimates mades later on in Chapter 5. These cost estimates are asfollows (inflation Eactor applied to (a) through (c) is 7.7% p.a., assuggested by the IBJID's forecasted international rate of inflation):

(a) real direct production costs will rise at 2.5%, slightlyslower than in the past, from a base of K 700/ton in 1976converted to account for the impact of devaluation on theapproximately two-thirds of costs with significant por-tions of imported inputs;

(b) real marketing costs will remain relatively constant attheir 1976 (post-devaluation) levels;

(c) real administration and related costs will rise at 2.5%,in line with direct costs, from the 1976 base largelyunaffected by devaluation; and

(d) finance charges (already in current prices) estimated tobe forthcoming on debt already contracted as of the endof the mining companies' fiscal year 1976.

The actual level of per-ton operating profits will depend, of course,on the actual level of these and other variables, such as the rate ofexpenditure for replacements charged against current operations. Oneforeseeable change is that finance charges will rise above currentlyprojected levels for two-three years hence and beyond, because financecharges on debt contracted after FY1976 could not now be confidentlyestimated. To this extent, the level of per-ton profits may be slightlyoverestimated.

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(i) the increasing ratio of sulphide (non-acid soluble)to oxide ores over time restricts opportunities forprocessing by means other than smelting; 1/ and

(ii) significant diversion of material flows away from thesmelter could upset a carefully determined balancebet-ween the processing units (leaching/electro-winningis a less expensive process than smelting but alsoallows for lower recovery).

Effective smelter capacity will be increased substantially in the near futureto overcome the constraint, as a result of two projects now under way (im-provement of ore handling at Mufulira and an overhaul at Luanshya). Bettermaintenance and operation (largely by insuring adequate supply of skilledpersonnel) could also boost effective capacity, perhaps by as much as 15% ormore at Rokana (which now produces some 65,000 tons of copper anodes).

5.07 The major long-run production constraint will be in the extractionof ore to feed into the available processing capacity. 2/ This represents aneed for considerable capital expenditure, both to maintain current extrac-tion capacity and to undertake major new mining development projects. 3/There is some question as to how much of this expenditure can be expectedto take place, however, particularly in the next two or three years, which(given the considerable lead-time required to install new capacity) wouldbe necessary if Zambia were to take full advantage of the expected rise inprices in the early 1980s. This problem is especially serious given thequadrupling of mining company indebtedness over the past five years to atotal of about X 400 million, of which up to K 200 million, now K 240 milliondue to devaluation, was contracted during fiscal 1975/76 when prices plum-meted. Much of the new and previously existing debt will come due by 1980.Debt service payments will, as a result, divert substantial amounts of finan-cial resources away from pressing capital investment requirements, at least inthe short-run.

1/ Increasing amounts of sulphide ore could be treated in leach plants ifthey are first passed through a roaster. Expansion of roaster capacityis now being considered in order to make this a viable alternative.

2/ As a partial alternative to developing traditional kinds of ore reserves,the treatment of old tailings (see paragraph 4.02) presents prospects fora (lower-cost) source of refined copper over the next decade or so. TheChingola Tailings Leach Plant Stage III project, which NCC! hopes toimplement soon, is expected to produce about 35,000 tons/year of finishedcopper by these means. This represents a substantial investment require-ment as well, however, now estimated at about K 140 million (includingworking capital and interest during construction).

3/ It is estimated that such aew mining developmencs outside current opera-tiors would recuire as much as US$6,000-7,000 cf investment per ton ofannual finished copper production capacit7.

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5.08 The absolute amount of required capital is difficult to gauge sincedevelopment plans vary as price expectations, financial and technical circum-stances change. Uncertainty as to future prospects also discourages companiesfrom preparing capital expenditure plans far in advance, so that the projectedlevel of investments beyond the next 2-3 years is probably underestimated. Itis also difficult (see paragraph 3.08) to know exactly what portion of theseexpenditures will go into mining and other processes, or what portion is direc-ted to development of near and additional production capacity rather than tocapital replacement and f.acilities designed to substitute for declining opera-tions. For illustrative purposes, however, the magnitude of capital expendi-tures for the next five years to undertake necessary investments as outlined inthis section and as currently foreseen by the mining companies is estimatedas follows:

Table 5.2: ESTITATED CAPITAL EXPENDITURES, 1977-81(Current K millions)

1977 1978 1979 1980 1981 1977-81

Major New Develop-ment Projects 54 96 112 66 38 366

Renewal, CapitalReplacement andReplated infra-structure Projects 50 56 56 60 49 271

Total 104 152 168 126 87 637

Source: Mining Coimpanies and Mission Estimates.

5.09 Total planned capital expenditure for the period 1977-81 is K 637million (compared with K 435 million spent in the previous five years) but,given that a large part of capital expenditure planning is done only threeyears in advance, the amount estimated for 1980 and 1981 may eventually berevised upwards. In constant 1969 prices, however, the currently plannedexpenditures total only an estimated K 262 million, nearly 20% less thanwas spent in the SNDP period. The availability of company earnings fromwhich to finance these expenditures will depend not only on actual unitoperating profits, but also on the level of production, taxation rates anddividend declarations. Assuming unit profit margins estimated as outlined inthe footnote to paragraph 5.05 and production levels projected in Chapter VI(see Table 6.1), the companies' pre-tax profits before depreciation couldreach K 1,550 million (in current prices). Subtracting the approximately K211 million which is scheduled for payment of principal of borrowings oncapital expenditure in 1977-81, some K 1,339 million could be available fortaxation, distribution as dividends, extraordinary items and financing of newcapital expenditures. If the share of profits taken by taxation and dividendsis no greater than about: 70% over the coming five years (it has in fact beenaround 65% in recent years, except during the extraordinarily high profit year

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of 1973, see Table 5.4 below), then up to two-thirds of the planned capitalexpenditures could be expected to be financed out of the companies' earnings.The acquiring of certain debts not yet recorded as of mid-1976, possibleincreases in the share of profits to be taxed or distributed to Government andprivate shareholders, and the possibility of slower-then-predicted increasesin world prices and Zambian finished copper production may reduce the amountof self-generated funds for investment below the forecasted amount, but itstill seems reasonable to assume that at least one-half or more of the capitalfor planned investment will be available from retained earnings. In thiscase, and given a correspondingly more favorable investment climate, it wouldbe reasonable to expect that the planned expenditures for the next five yearscan be made.

5.10 Judging by the companies progress in recent moaths, they are un-likely to be able to spend the full amount forecasted for 1977, but theywill most likely delay rather than cancel planned expenditures. This willraise the ultimate capital expenditure total, however, due to additionalinflation, and may further delay certain expansion projects. In addition,slower than expected recovery of profit levels may require additional debtfinancing to be obtained. Necessary replacements might be financed with thehelp of existing and expected export guarantee and other suppliers' credits,although financial coustraints may cause certain development activities tofall behind somewhat.

5.11 Of the major new development projects, it is probable that thethird stage of the NCCH Chingola Tailings Leach operation (TL III) and thesecond stage of the full-scale development of Baluba mine at RCM's LuanshyaDivision will be carried out. Although particular financial sources stillremain to be arranged, the relatively attractive rates of return on theseprojects and their importance to the companies' efforts to lower unit produc-tion costs in the Copperbelt should cause the companies to do all they can tosee that such financing becomes available. Current financial constraints maydelay their implementation by one year or so, however, so that the forecastof likely future production in Chapter Vl assumes that TL III will not befully operative, and that Baluba Stage II (mining operations) will not befully completed, until 1981. It also assumes that sufficient investmentswill not be made to allow significant operations to begin at NCMI's Kansanshior BCX's Kalulushi East projects before the end of the TNDP period (1982),in the absence of an extraordinary rise in copper prices, because of theirweighty capital and iafrastructure requirements compared to currently expectedreturns.

C. Production Costs

5.12 It is likely that the trend increase of real unit production costsfor finished copper will remain steady or decline slightly in the near futurecompared with recent experience, i.e., costs may be expected to increaseat an annual rate of 2.7% or slilghtly less. This situation Dresents little

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cause to fear that mining in Zambia, while relatively high-cost, will becomeeither uncompetitive or (given current IBRD price forecasts) unprofitable.This is not to say, however, that the composition of cost increases will re-main the same, nor that small changes in cost trends would not have signifi-cant impact on profitability or other determinants of production. Amongmajor uncertainties affecting costs, precipitous changes in the market priceof copper will affect investment, extraction and other policies that couldcause the real cost trend to vary. There is also the possibility that otherforces (especially the lack of qualified personnel) might affect productionnot only indirectly through their impact on costs but also directly throughtheir lessening of effective production capacities. Finally, while the upwardtrend in real costs may continue, nominal costs may continue to rise fasterdue to the need to service an increasing indebtedness, until sufficientprofitability is restored to repay the recently contracted debt and/or tofinance the considerable capital expenditure needs of the mining companies inthe next few years. Marketing costs are expected to level off, as TAZARAmatures and Dar es Salaam port becomes more efficient.

5.13 The expectation of production cost increases continuing at a steadyor slightly declining rate is based on an assumed balancing of countervailingforces and few changes in government policy. Among the most important influ-ences on cost:

(i) Reserve grade and dilution factors are expected tocontinue causing production costs to increase at aconstant rate. This assumes a relatively constant rateof dilution and a continued steady decrease in reservegrade, both of which may be influenced by changes inextraction policy. Reserves themselves may also varyas new deposits may be explored and developed, or asmore low grade (1.0% and lower) materials produced inprior operations become economically recoverable by theintroduction of additional solvent extraction facilities(especially Chingola Tailings Leach Plant Stage III).This will exert a significant cost-decreasing influencein the next few years that should reduce the rate ofunit production cost increases generally, but thiseffect may be somewhat diminished in later years by thefact that among copper produced from mined ore (ratherthan tailings) a greater percentage of ore may becoming from the relatively more expensive underground,rather than open pit, mines.

(ii) Labor productivity might also be expected to continuedeclining, given the somewhat alarming level of currentvacancies for skilled expatriates (16% of expatriatelabor force in both companies) and the relative inex-perience of many already engaged. Particular problemsare being enccountered with respect to artisan positionsnecessary to maintain equipment, which are thereforeaffecting the productivity of the labor force as awhole. The training of Zambians for skilled jobs in

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mining and metallurgy is also delayed by the shortageof qualified personnel, both in company training pro-grams and in the general secondary education systemwhich must prepare qualified candidates.

University training has produced relatively fewmining graduates compared to current need and previousexpectations. A 1974 government forecast projectedthat by now 70 Zambian graduates per year (of theUniversity of Zambia and overseas institutions) mighcbe ready to enter mining operations, but due to a lackof qualified candidates and the diversion of many intothe agriculture and architectural faculties, only 12graduates are expected this year. Although there areindications that most of those Zambian graduaces who haverecently entered the workforce are performing relativelywell, the current forecast is for uneven and insufficientgrowth to achieve original targets in the coming years.In any event, over the next few years it will be crucialto attract a good number of skilled expatriates, not onlyto prevent a further decline in overall productivity butalso to maintain effective production capacities.

Table 5.3: FORECASTED NUMBES OF GRADUATES LN MINING AND RELATEDFIELDS FROM UNIVERSITY OF ZAMBIA, 1977-83 /a

Tyve of Graduates 1977 1978 1979 1980 1981 1982 1983

Metallurgists 6 6 13 8 10 6 10Mining Engineers 3 6 13 8 10 6 10Geologists 3 1 6 5 4 5 4

Total 12 13 32 21 24 17 24

/a Does not include Zambians expected to receive degrees abroad,who should number about five per year.

Source: Ministry of Mines and Industry.

(iii) Costs of inventories of spares and stores should beless of a problem, however. Although ever-presenttransport uncertainties will prevent significantdrawing-down of stores, the growing dependability ofthe Dar es Salaam route should preclude the need forany appreciable increases in the level and cost ofstores. The costs of any increased delays due topossible resumpcion of heavier import traffic alongthis route could be comDensated for bv the growingstandardization of noa-South African equipment, whichwould reduce the need for maintaining "cual" stores.

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El. Government Policies and Actions

5.14 While the Zambian copper industry has been subject to a number ofunpredictable events beyond the country's control (world market price varia-bility, transport routet closings, etc.), certain government policies andactions have also affected the companies' financial requirements and avail-abilities and their production costs. The future course of goverament policyis likely to have a growing impact not only on these factors but also directlyon production levels as. well. Government influence is manifested both in cap-ital investment plans and the availability of resources to finance them, andin certain elements of rising production costs (which affect, in turn, theindustry's competitiveness and its financial performance). Through itsmajority on company directorates, Government makes decisions which affectthe location and magnitude of capital investments, either directly or in-directly. It helps determine the availability of financial resources forsuch investment and for maintenance, most directly through taxation and divi-dend decisions, which affect the companies' internal financial flows. Whenthese resources are insufficient to finance investment, the companies mustseek debt finance usually abroad and at increasingly expensive terms (oftendue to government financial policies which can reduce the credit rating of thecompanies). Government can also affect production costs, through policiesthat have an impact on:

(i) the availability of skilled personnel, either from domesticeducational institutions or those who can be attracted fromabroad;

(ii) the timely availability of foreign exchange for the purchaseof necessary import inputs; and

(iii) the grade of ore mined, depending on extraction policies,which affects the extraction requirements for each ton offinished copper produced.

Production levels could be directly affected if there were a serious shortageof personnel or equipment (reducing effective production capacities as wellas increasing costs), or if international efforts to restrain copper exportswere to be more effective (although higher prices would presumably compensatefor such decreases in production).

5.l5 With regard to capital investment, Government's majority on thecompany directorates alLows it to have a determining voice in decisions asto the nature and locatLon of development projects. This applies not onlyto investments at new mLning locations, but also to major capital expendituresfor the renovation of facilities at ongoing operations or for expanding suchoperations (e.g., sinking new shafts in older mining complexes) in order tomaintain production levels. Because Government's priorities must take intoaccount socio-political considerations (such as regional development), invest-ment decisions sometimes favor projects in outlying areas (e.g., Kansanshi),requiring heavy capital expenditure for major infrastructure development (andperhaps causing operational costs to remain at a relatively high plateau).

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Certain other investments may be made to maintain production levels at opera-ting mines on which surrounding communities are dependent (e.g., Luanshya)either by replacing older operations with new capacities or by beginningless costly operations that would keep overall production there viable.

5.16 Government policies also affect the availability and cost of finance.While prior to the 1970 takeover financial resources could be raised partiallyby share issues, the share capital of the mining companies has not beenincreased since then. Government maintains its 51% ownership, and doesnot intend either to subscribe additional capital nor to permit others todo so and thereby acquire majority ownership. 1/ Some small loans (or grants)have been made by Government to the companies, however. Government revenuesfrom the mining sector are generally channelled to other sectors.

5.17 The availability of internally generated finance for capital spend-ing is also dependent on government taxation policies and dividend policies(which it effects through its majority shareholding). The changing mix oftaxation laws in recent years (including variable treatment of depreciation,selective employment taxes, etc.) has caused the overall tax burden to vary.Government's share of mining company profits (taxes and dividends, beforedepreciation) during the last five years has tended to increase in the moreprofitable years, reaching as high as 73.12 in 1973.

Table 5.4: GOVER.NKT REVENIES AND COMPANY RETENTIONSFROM MIrNLG COMPANY PROFITS, 1970-75

(K millions)

1970 1971 1972 1973 1974 1975

Profits (Losses), /a 289.9 154.1 178.9 499.0 179.0 (63.3)of which:Taxes 121.7 42.8 51.2 308.0 87.9 -Dividends 62.8 56.5 67.0 111.3 23.5 -

Government Revenues(Taxes + 0.51 x Dividends) 153.8 71.6 85.3 364.8 99.9 -(As a 2 of Gross Profits) 53.1% 46.5% 47.7% 73.1Z 55.8% -

Retention of Profits(before deDreciation) 105.4 54.8 60.7 79.7 67.6 -

/a Before deducting depreciation.

Source: Annual Reports, Mission Estimates.

1/ As a result, the mining ccmpanies will continue to finance capitalexpenditures through retained earnings and debt financlng which doesaot yet seem to be constrained by the comDanies' eouit-7 base.

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5.18 Funds for investment must continue to come from the companies'cash generation and borrowings. Until the spectacular fall in earnings in1974-75, the companies had prudently financed up to two-thirds of their invest-ment out of retained earnings. Since that time, however, the mining companieshave had little recourse other than to borrow heavily from abroad, especiallyin order to maintain majcor new investments embarked upon during the periodof high copper prices imuLediately preceding the fall in prices. Even thissource of financing has not always been available in the last year or two,however. 1/ This is due not only to the general malaise affecting the copperindustry which makes it a less attractive potential borrower, but also toexternal financial instit:utions' reluctance with regard to the country'screditworthiness. Part of this problem arises from the fact that the companiesmust conduct all foreign exchange transactions through the Bank of Zambia,which in the face of present difficulties has had to delay payment obligations.

5.19 As a result of this lack of sources for external financing, theZambian mining companies are to a certain extent dependent on official exportfinancing. The companies must therefore purchase goods in countries whoseexport finance agencies are willing to participate, and the reduced opportuni-ties for "shopping arouncl" may often result in higher import prices. Certaintypes of capital project expenditures cannot be funded at all through theseprocedures, including fuel, spare parts, labor and other costs not directlyconnected with equipment purchases from the foreign supplier. Many of theseadditional inputs are at the same time being less efficiently and more expen-sively supplied to the m:Lning companies by local firms, who are unable tomaintain a steady inflow because of delays in obtaining import licenses and/orexchange allocations through a cumbersome bureaucratic process.

5.20 With regard to longer-term debt, it has already been mentioned thatthe requirement that the mining companies must conduct all major foreignexchange transactions through the Bank of Zambia means that the companies'creditworthiness is linked to that of the Government. This, along with thefact that lenders have become accustomed to receiving government guaranteesfor major loans to mining companies since 1975, now makes it practicallyessential for the companies to obtain such guarantees in order to get anyexternal financing. The Minister of Finance announced in his January, 1977,Budget Speech that hence..orth such guarantees will only be granted at a costto the borrower of 1.25% of the loan principal. Finally, the largest nominaladdition to the cost of eaxisting debt was the June 1976 devaluation of theKwacha, which increased outstanding foreign indebtedness by K 59 million at astroke, although it also had a salutary effect on company finances. 2/.

1/ Witness the long delay in attempted borrowing for attractive projectssuch as NCCK's Chingola Tailings Leach Stage III operation.

2/ The devaluation, of course, increases the Kwacha value of earnings, anostensible reason for the devaluation. The overall impact of the devalua-tion on balance is difficult to determine, given the price variabilitywhich also affects earnings subsequent to the devaluation and the needto deduct from increased earnings not only increased indebtedness butalso the increased effective price of supplies already purchased butnot yet delivered.

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3.21 It is not likely that government financial policies will changesubstantially in the near future. Financial constraints caused thereby maytherefore be expected to continue restricting the mining companies fromobtaining finances abroad on the best possible terms in order to expandtheir operations to their full technical and economic potential. This doesnot alter the forecast made in paragraph 5.11, that, on the basis of care-ful examinations of the companies' financial plans, profit and pipeline ofdevelopment projects, at least two major projects will be implemented andmost ongoing operations will be maintained during the coming years. In theabsence of changes in government financial policies discussed above, how-ever, further expansion would be contingent on substantial increases ia worldcopper prices, some of the subsequent profits of which would provide invest-ment capital and a more favorable climate for obtaining external financing.

5.22 Government policies and actions also have a significant impacton production costs and other determinants of production levels, althoughnot always so directly as on company finances as described above. As thesepolicies affect the cost elements considered in section C, the question ofgreatest concern at present is that of labor productivity and availability.Until sufficient Zambian graduates are available to fill more skilled laborerand mine management positions, the mining companies will remain largelydependent on their expatriate staff. The alarming reduction in size andexperience of the expatriate labor force, especially in the last two years,is said to now be hindering production. The productivity decline is also at-tributable to expanded administrative staffs of the mining companies, largelyan unexpected result of Zambianization efforts.

5.23 The rapid turnover and increasing difficulty in filling vacancies(see nara. 5.13) is due to a combination of factors. The problem of rapidturnover of expatriate personnel is attributable to, inter alia:

(i) the declining standard of living conditions (e.g.,constant shortages of basic foods like milk, eggs,butter, etc.);

(ii) the desire of expatriates to be allowed to externalizea larger share of their earnings (1/3 of salary pluscertain gratuities can aow be repatriated except intimes of emergency); and

(iii) uncertainty over future political and economic conditions,the latter factor being responsible for the departure ofmany expatriates with up to 20 years or more of in-valuable experience who prefer to pursue their careerelsewhere aow, before they become so senior that prospectsfor further transfer are minimal.

Knowledge of these factors, a tendency to associate Zambia with politicalunrest elsewhere in southern Africa and generally uncompetitive salary packageshave made it imossible to replace the lost expatriate personnel in terms oaumbers or experience.

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5.24 As competition for skilled personnel can be expected to increasewith the expansion of copper production in other countries, the course ofGovernment policies may be the determining factor in the attempt by Zambiancompanies to maintain essential and qualified expatriate personnel. First ofthese is the education of Zambians to fill positions currently held by expa-triates; this policy is being followed but with only limited success (see para5.13). Second is the improvement in the amount and ability to externalizebenefits paid to expatriates. Government has recently increased tax-freegratuities (which can be externalized) for lower paid expatriates, but ingeneral, continuing uncertainty over benefits and delays in their implementa-tion have reduced their effectiveness in encouraging expatriates to remain.The importance of security, both perceived and real, must also be stressed.The attractiveness of Zabia as a place of employment will depend on Govern-ment attempts to convince both current and prospective expatriate employeesof their safety in Zambia and to provide suitable housing and at least basicconsumer items for purchase.

5.25 Government regulation is also partially responsible for othersources of cost increases. Uncertainty and delays in obtaining foreignexchange have already been cited as a source of rising financial costs (seepara. 4.23). Similar regulatory procedures also impede the steady flow ofcertain inputs needed to maintain the companies' equipment and; in turn,the productivity of their labor. This is true for a variety of inputs inshort supply (which has increased with the growing number of different foreignsources of equipment), even though the majority may have now been stockpiled(see paras. 4.20-4.24). 1/ Many domestic suppliers of these parts, whountil recently provided a reliable service at competitive prices, have beenunable to function because of an inability to obtain either foreign exchangeallocations or import licenses, or both. 2/ Although the mining companies,who are becoming increasingly responsible for importation of their own supplies,are ostensibly accorded priority in obtaining the necessary foreign exchange,company sources indicate that they continue to face delays. While the relativeshortage of foreign exchange may prohibit Government from lifting its exchangeregulation in the short term, the companies could be assured of a certainminimum of timely foreign exchange allotments (perhaps as a percentage ofearnings) so that they can plan appropriately to make optimal use of theirresources. Discouragement of importing through bureaucratic delays merelyadds costs through inefficiency, and can effectively reduce the revenues ofZambia's primary earners of foreign exchange.

1/ The costly increase in inventories is to some degree a result of thecompanies' stockpiling when foreign exchange is available, to insureagainst times when foreign exchange allocations might not be available.

2/ This is a wider problem, not limited to firms related to the miningsector.

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5.26 Availability of both labor and essential spares affects productionlevels not only through their impact on costs, but also (in the case ofsevere or strategic shortages) can constrain production directly. Thisis also the case with Government's impact on production through its miningand extraction policies. Government extraction and reserves policies areobscure (partially due to the number of different voices within the Governament,see paras. 2.03-2.05), but are crucial to future production prospects. Whilein underground mining operations, which rpmnin the largest source of containedcopper by far, higher-grade ore bodies could be selected for extraction,Government inspectors attempt to insure that all mineable ore that can besafely extracted from them is taken. While insuring that copper ore reservesare not excessively depleted, this policy also reduces the grade of oreproduced and increases the unit costs of finished copper. Therefore, engagingin a mining process that does not involve maximum possible extraction wouldreduce costs, but at the-expense of some ore reserve depletion and reducedproduction.

5.27 Finally, future production might also (but will not likely) beaffected by possible government-i=posed production ceilings. Zambia is afounding member of CIPEC, the Intergovernmental Council of Copper ExportingCountries, which is composed of most major copper exporters (Zambia, Zaire,Chile, Peru, Australia, Indonesia, Mauritania and Papua New Guinea). CIPEChas attempted to improve market conditions by imposing export limitations onits member countries since 1974. The successful of these attempts is question-able, 1/ and based on this experience, it is unlikely that future absoluteproduction limits will be effectively enforced. If such changes were tooccur, however, they could alter estimates of future production.

CAPTER VI. FUTURE COURSE OF PRODUCTION

6.01 The variety of factors which determine the course of finishedcopper production is so wide that it is impossible to predict confidentlyexact levels of future capacity, or output. The overriding economicimportance of the sector and its traditional role as Zambia's principalsource of foreign exchange earnings, however, make forecasting essential.It can also be a useful exercise in terms of bringing together the aumerousvariables which affect production, determining the aggregate impact of theirexpected future courses and quantifying, where possible, the changes inproduction level which might be attributable to possible events outsideof Zambia, to changing policies of Government, or to decisions of the miningcompanies themselves.

1/ In accordance with CIPEC guidelines, Zambia announced an intended cut-back in 1975 copper sales abroad by an amount equivalent to 15% of thevolume exported between June and November, 1974; this restriction wasextended to the first six months of 1976 as well. It is not clearthat these restrictions had their full intended effect on Zambiancopper extorts: during 1975, copper exports were only 5%o below thoseof 1974 and 3% below the annual equivalent of the June-November 1974rate of extorts; copper ex-orts during the first half of 1976 wereactually 8t higher than the June-November, 1974 level.

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6.02 In projecting Jfuture levels of production, a process which iscurrently underway at the Ministry of Development Planning for purposes ofcompleting the Third National Development Plan (TNDP, 1978-82), two lessonsfrom the experience of the SNDP period should be kept in mind. The first ofthese is that it is dangerous to put faith in mere extrapolations fromrecent trends. The SNDP was prepared at a time of relative optimism when,after the expected recovery of production at Mufulira, it was assumed thatfuture revenues from Copperbelt production would rise sharply. The lack ofknowledge of the events to follow, especially the abrupt losses of transportroutes to the sea and ext:reme levels of price fluctuation (in both amplitudeand frequency), made appropriate contingency planning difficult. Currentforecasts should realistLcally take these recent occurrences into account,but should not (as some officials seem to be doing) repeat the SNDP mis-take in reverse, by assuaing that the low level of production and profits inrecent years will also continue indefinitely. Indeed, a second lesson fromthe SNDP experience is that the Zambian copper industry can fare remarkablywell (by even maintainin; production levels) in the face of great difficultiesand, given even their partial resolution, substantial progress could be made.The substantial increase of 11.3% in production to 712,900 tons in 1976from 640,300 tons the previous year is indicative of the industry's resource-fulness.

6.03 The production forecast which follows indicates likely future out-put in the absence of major external shocks, 1/ such as further loss of accessto sea ports or a serious deterioration in the southern African politicalclimate that could cause the skilled expatriate personnel situation to worsento a degree such that production could not continue at current levels. Pricesare assumed to follow an upward trend, as detailed at the beginningof Chapter V, or at least to remain sufficiently high so as to make continuedproduction and future ivrestment reasonably profitable. Cyclical output varia-tions due to year-to-year price fluctuations, while not changing the fore-casted trends, will affect the companies' ability to finance capital investmentsand, as far as current price variations cause long-range price expectations toshift, capital expenditure plans may change as well. Still, it is consideredlikely that capital inve3tments outside of replacement expenditures and twonew major development projects (Chingola Leaching Stage III and Baluba StageII) will be difficult to advance in the foreseeable future.

6.04 One additional factor which must be taken into account is that ofGovernment's impact on production. The skilled labor situation, affected byGovernment both through its domestic educational efforts and its ability toattract and retain experienced staff from abroad, is expected to remainserious. An assumption maust be made, however, that Government and the companieswill continue to take positive steps to correct this situation before it

1/ This production forecast is based on high (90%) utilization of capacityexpected to be in pLace by the mining companies. While the productionforecasts provided to the Mission by the companies must be treatedconfidentially, the data included therein were in aggregate used to forma base set of projections. These were later adjusted to reflect theMission's judgment as to when facilities will actually be operational andnecessary minor revisions in effective capacities of older mines.

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deteriorates much further (although in the short run, the decline of laborproductivity and its effects on production costs are assumed to continue at aconstant pace, until lost experience can be regained). Government action toaccommodate the companies' financial needs is also expected, as maintenance ofplant and scheduled new development projects are essential to maintain orincrease production and employment levels at ongoing aines.

6.05 Given the preceding conditions, future production levels areexpected to be as follows:

Table 6.1: PROJECTIONS OF FINISHED COPPER OUTPUTFROM COPPERBELT, 1977-83

(M1etric tons)

Finished MillionCopper Tons of Ore

Year Production ('000) Extracted

1975 ) 640.3 34.31976 actual 712.9 35.5

1977 714.5 34.81978 724.4 35.81979 734.2 36.41980 742.8 36.91981 748.9 37.31982 757.2 37.21983 759.8 37.2

Source: Mining Company Forecasts and MissionProjections.

Finished production is expected to increase at a rate of approximately 1.0%between 1976 and 1983, when production of finished copper is expected topeak at 760,000 tons. Estimated production of ore rises at a rate of only0.65%, as at least half of the production increase is accounted for by thebringing into operation of the Chingola leach plant to treat old tailings,the extraction of which was already accounted for in the production of copperprocessed when the tailings were set aside. The tons of ore actually producedper ton of finished copper from traditional sources is expected to rise, butnot so much that it will outweigh the savings represented by the tailingsleach operations.

6.06 The expected production resulting from new projects currentlyunder development will represent increments to total output in the nextfew years, although a growing part of this production will be compensatingfor declining output at certain currently operating mines and facilities.Unless substantial additional investment is undertaken in the near future(at locations such as those listed in Table 5.2), total sectoral cutputcould well begin to decline after 1983. At present, such a decline (ofperhaps 1 ?er annum) seems possible, although this view reflects in part

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the companies' tendency to resitrict serious investment planning to theshorter term. If the industry's prospects brighten over the next few years,however, additional investment: could take place that might maintain or evenexpand capacity and production in the later 1980s. Such a situation isunlikely to occur unless copper prices rise so steadily that they would justifythe increasingly expensive development which would have to take place atoutlying or currently operatinig mines, many of which would by then be so deepor their resources so depletesl that the marginal cost of production wouldinhibit expansion or even replacement to maintain production.

6.07 It should be stressed that these projections are intended to giveonly an idea of production trends, and are highly contingent on notoriouslyunpredictable variables, only some of which are in Zambia's hands to deter-mine. Were all investment capital sources to dry up precipitously or futureprice prospects to remain bleak, for example, investments designed to yieldclose to 60,000 tons of finished copper during the next few years would nottake place, and countless add:ftional tons would not be produced because ofrising unit costs or insufficient maintenance. On the other hand, significantimprovement in price prospects could lead to investments that might maintainsteady growth in production through the 1980s, if this were in line withoverall development planning in Zambia.. The personnel situation is perhapseven more volatile and diffic ult to quantify, although it also has thepotential for causing greater losses in production should problems continuethan increases in production should the situation improve. Still, the inherentstrength of the industry and its ability to reain relatively healthy duringits most difficult years suggest the probability that small but significantprogress can be expected duriag the next development plan period and perhapsbeyond if concerted efforts are made by the mining companies and their majorityshareholders, the Government of Zambia.

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